Saturday, December 30, 2006

Economics for (Euro) Dummies

From The Brussels Journal:

On January 1 2007, Europe celebrates the fifth anniversary of the launch of euro notes and coins by welcoming a 13th member of the eurozone – Slovenia, the tiny former Yugoslav republic. But the eurozone’s geographical expansion is modest in comparison with the rapid growth in euro notes in circulation within the region and beyond. Earlier this month the value of euro notes pushed through the €600bn (£402bn, $787bn) level – roughly double the value of the then-national currencies in circulation at the end of 2001. The signs are that in December the currency came of age by overtaking the US dollar in terms of the value of notes in circulation.

Pay attention to the part where it says that the value of euro notes is now twice the value of the national currencies that they replaced. We should point out here that by "value" they mean the face value, not purchasing power. Now here's the first test question:

Do you believe that the productivity of the European member states has doubled in the past five years?

If you've been paying attention to the stagnant European economic situation with its anemic growth rates the answer will be an obvious no.

This leads us to the second test question:

If you double the amount of currency in circulation without doubling the economic strength backing that currency what will happen to the purchasing power of that currency?

If you said that it will fall by nearly half then you get the gold star. Twice as many bank notes chasing the same amount of goods will each buy half as much. This is called inflation and it is caused more than anything else by governments issuing currency which is unbacked by reserves of precious metal and then turning on the printing press and growing the money supply.

If you doubt this then study the history of the Weimar Republic, which sought to pay striking workers and pay off war debt by turning on the printing press. The result had people burning money because it was cheaper than firewood.

The fact that the inflation rate in Europe has not been nearly 100% (there has been some growth in the European economies after all) means that there is a very large and heavy "other shoe" getting ready to drop in Europe.

I'm afraid that the "thump" when it hits the ground somewhere between Paris and Berlin will send out vibrations that will be felt in North America and Asia as well.

As the Chinese said, interesting times.